Consumption and economic growth

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Snapshot for February 6, 2002.

Consumption and economic growth The Bureau of Economic Analysis recently reported that economic growth in the fourth quarter was positive at 0.2%. An important reason why economic growth was not negative, as many observers had believed it would be, was that consumption increased at an annualized rate of 5.4% (it had only increased by 1.0% in the third quarter).

However, consumers are slowly reaching the limit of their ability to shop. In fact, consumption relative to personal disposable income reached a record high of 96.3% last quarter. It was not a surge in personal income that gave rise to the consumption boost in the fourth quarter — the consumption increase was fuelled instead by a rapid increase in consumer borrowing. Consumer borrowing relative to personal disposable income (PDI) also reached a record high of more than 22%.

These trends have important implications for the future. Record household debt is also reflected in near record levels of interest payments, debt service burden, and personal default rates. As a consequence, banks will become more careful and stop lending to protect their assets. Also, given that households reached record highs both in terms of their relative consumption and debt levels, it seems unlikely that they will go out and increase their borrowing and spending at the same rate as they did in the fourth quarter. Without solid income growth, consumption growth is likely to be slow in the near future.

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EPI is an independent, nonprofit think tank that researches the impact of economic trends and policies on working people in the United States. EPI’s research helps policymakers, opinion leaders, advocates, journalists, and the public understand the bread-and-butter issues affecting ordinary Americans.